Absorption Costing and Marginal Costing

Absorption costing and variable costing are the two main techniques of
cost ascertainment and income determination. The basic point of
distinction between the two is regarding the treatment of fixed
manufacturing overheads. In absorption costing, all variable
manufacturing costs and also fixed manufacturing cost are included in
the cost of product i.e cost of goods produced includes all manufacturing
cost.
Both absorption costing and marginal costing treat non-manufacturing
cost (i.e administration, selling and distribution overhead) as period
costs.
Absorption costing is mostly used for external reporting and computation
of taxable income. Variable costing is mostly used for internal reporting
i.e it is used for managerial purposes.
Absorption Costing
This is a total cost technique under which total cost (i.e variable
manufacturing cost as well as fixed manufacturing cost) is charged as
production cost. In other words, in absorption costing, all manufacturing
costs are absorbed in the cost of the products produced.

Characteristics of Absorption Costing

1. Both variable manufacturing costs and fixed manufacturing costs
are charged to cost of products
2. Stocks are also valued at total cost i.e. variable plus fixed cost
3. Fixed cost are charged on actual basis or at pre-determined
overhead rates
Income Statement (Absorption Costing)
Particulars Rs
Sales
Production Cost
1. Direct materials
2. Direct labor
3. Variable Cost
4. Fixed manufacturing cost
Cost of Goods produced
Add: Opening stock of finished goods (valued at cos of previous
periods production)
Less: Closing Stock of finished goods (Value at production cost of
current period)
Cost of Goods Sold
Add/Less: under/over absorption of fixed manufacturing
overheads
Add: Selling and distribution costs
Administration costs
 Total Cost
Profit (Sales – Total Cost)

Meaning of Marginal Cost and Variable Cost

Marginal Cost is the same as variable cost. Marginal cost is the
additional cost of production an additional unit of product. It is the total
of all variable costs. It is composed of all direct costs and variable
overheads. The CIMA London has defined marginal cost ‘as the amount
at any given volume of output by which aggregated costs are changed, if
volume of output is increased or decreased by one unit’.
Characteristics of Variable Costing
1. Segregation of costs into fixed and variable elements
2. Variable costs as products costs
3. Fixed Cost as period costs
4. Valuation of inventory
Income Statement (Variable Costing)
Particulars Rs
Sales
Variable Manufacturing Cost
1. Direct materials
2. Direct labor
3. Variable manufacturing Cost
Cost of Goods produced
Add: Opening stock of finished goods (valued at variable cost of
previous periods)
Less: Closing Stock of finished goods (Value at current variable
cost)
Cost of Goods Sold
Add: Variable – Administration and Selling and distribution costs
Total Variable Cost
Contribution (Sales – Variable Cost)
Less: Fixed Cost (production, administration, selling and
distribution)
Net Profit

Problem – 1
From the following information prepare an Income Statement under:
a) Marginal Costing b) Absorption Costing
Particulars X Y Z
Direct materials 7,500 30,000 3,000
Direct Wages 9,000 9,000 1,500
Factory Overheads – Fixed 3,000 1,500 1,500
Variables 3,900 9,000 4,500
Selling Overheads - Fixed 1,500 900 600
Variables 2,100 6,000 3,000
Sales 32,000 61,000 16,000
Fixed Factory overheads and fixed selling overheads were apportioned to
products X, Y, and Z on equitable basis
Solution
Income Statement (Absorption Costing)
Particulars X Y Z Total
Sales (A) 32,000 61,000 16,000 1,09,0
00
Production Cost
Direct Materials 7,500 30,000 3,000 40,500
Direct Wages 9,000 9,000 1,500 19,500
Factory Overheads (Fixed + 6,900 10,500 6,000 23,400
Variable)
Selling Overheads (Fixed + 3,600 6,900 3,600 14,100
Variable)
Total Cost (B) 27,000 56,400 14,100 97,500
Profit (A-B = C) 5,000 4,600 1,900 11,500

Income Statement (Marginal Costing)

Particulars X Y Z Total
Sales (A) 32,000 61,000 16,000 1,09,0
00
Variable Cost
Direct materials 7,500 30,000 3,000 40,500
Direct Wages 9,000 9,000 1,500 19,500
Variable Overheads
Factory 3,900 9,000 4,500 17,400
Selling 2,100 6,000 3,000 11,100
Total Variable cost(B) 22,50 54,000 12,00 88,50
0 0 0
Contribution (A-B) 9,500 7,000 4,000 20,500
Less: Fixed Cost (Factory + 9,000
Selling )
Profit 11,500

Problem – 2
XYZ ltd. supplies you the following data for the year ending 31 st
December 2023
 Production – 1,100 units, Sales 1,000 units
  There was no opening stock
 Variable manufacturing cost per unit Rs. 7
 Fixed manufacturing overheads (total) Rs. 2,200
 Variable selling and administration overheads per unit Rs. 0.50
 Fixed Selling and administration overheads Rs. 400
 Selling price per unit Rs. 15
Income Statement under Variable Costing
Income statement under absorption Costing
Explain the difference in profit under Variable and absorption costing

Solution
Income Statement (Absorption Costing)
Particulars X
Sales ( 1,000 @15) 15,000
Variable manufacturing overheads (1100 units 7,700
@ 7)
Fixed manufacturing overhead ( 1100 units @ 2,200
2)
Cost of goods produced 9,900
Less: Closing Stocks (100 units @ 9) (7 + 2) 900
Cost of Goods Sold 9,000
Add: Selling and administration overheads
Variable (1000 units X Rs. 0.50) 500
Fixed 400
Total Cost 9,900
Profit (Sales – Total Cost) 5,100

Income Statement (Marginal Costing)

Particulars X
Sales ( 1,000 @15) 15,000
Variable manufacturing overheads (1100 units 7,700
@ 7)
Less: Closing Stocks (100 units @ 7) 700
Cost of Goods Produced 7,000
Add: Selling and administration overheads
Variable (1000 units X Rs. 0.50) 500
Total Variable cost of goods sold 7,500
Contribution (sales – Variable Cost) 7,500
Less: Fixed Cost (manufacturing + Selling + 2,600
Adm)
Profit (Sales – Total Cost) 4,900
Problem – 3
XZED limited sells its products at Rs. 3 per unit. The company uses a first
in first out actual costing system. A new fixed manufacturing overhead
allocation rate is computed each year by dividing the actual fixed
manufacturing overheads cost by the actual production cost. The
following simplified data are related to its first two years of operations.
Particulars Year –I Year – II
Sales (units) 1,000 1,200
Production (units) 1,400 1,000
Cost Rs Rs
Variable manufacturing 700 500
Fixed manufacturing 700 700
Variable Marketing and administration 1,000 1,200
Fixed marketing and administration 400 400
Prepare Income statement based on
1. Absorption costing
2. Marginal Costing
3. Give Reasons for difference in answer
Solution
Income Statement (Absorption Costing)
Particulars Year –I Year – II
Sales 3,000 3,600
Manufacturing (Fixed + Variable) 1,400 1,200
Add: Opening stock of finished goods - 400
Cost of Goods Available for Sale 1,400 1,600
Less: Closing Stock of finished goods 400 240
Cost of Goods Sold 1,000 1,360
Marketing and Administration cost 1,400 1,600
(Variable + fixed)
Total Cost 2,400 2,960
Net Income (Sale – Total Cost) 600 640

Income Statement (Marginal Costing)

Particulars Year –I Year – II
Sales 3,000 3,600
Variable Manufacturing Cost 700 500
Add: Opening Stock of Finished goods - 200
Cost of Goods Available for sale 700 700
Less: closing Stock 200 100
Cost of Goods Sold 500 600
Variable Marketing and adm cost 1,000 1,200
Total Variable Cost 1,500 1,800
Contribution (sales – Variable cost) 1,500 1,800
Less: Fixed Cost 1,100 1,100
Net Income 400 700

Problem – 4
The following is the standard cost data per unit of product ‘X’
 Selling price 40
 Direct material 8
 Direct labour 5
  Variable factory overhead 2
Fixed factory Rs. 5 (based on budgeted normal output of 36,000 units per
year)
Variable selling overhead Rs. 6
Fixed Selling overheads per year were Rs. 1,20,000
During a month the company produced 2,000 units of the product ad sold
1,500 units. There was no opening stock
You are required to prepare an income statement
 Absorption costing
 Variable costing
Explain the difference in profit if any

Solution
Income Statement (Absorption Costing)
Particulars Year –I
Sales (1,500 units X Rs. 40) 60,000
Production Cost
1. Material Cost (2,000 X 8) 16,000
2. Labour cost (2,000 X 5) 10,000
3. Variable Factory Overheads (2000 units X 2) 4,000
4. Fixed Factory Overheads (2000 units X 5) 10,000
Cost of goods produced 40,000
Less: Closing Stock of finished Goods (500 X 20)* 10,000
Cost of Goods Sold 30,000
Add: under Absorbed overhead 5,000
Add: Selling expenses – variable (1,500 units X rs. 6) 9,000
Fixed (rs. 1,20,000 /12 months) 10,000
Total cost 54,000
Profit (sales – Variable Cost) 6,000

Working Note:
Closing stock is valued at production cost per unit (i.e) Rs. 40,000 / 2000
units = 20

Fixed Factory overheads per month is (36,000 * 5)/12 = 15,000

Less: Fixed Factory overhead absorbed (2000 * 5 ) = 10,000
Under absorbed overheads 5,000

Income Statement (Marginal Costing)

Particulars Year –I
Sales (1,500 units X Rs. 40) 60,000
Variable Production Cost
1. Direct Materials (2000 units X 8) 16,000
2. Direct Labour (2000 units X 5) 10,000
 3. Factory Overheads (2000 units X 2) 4,000
Total Variable Overheads 30,000
Less: closing Stock of finished Goods (500 * 15) (30,000 / (7,500)
2000 units)
Add: Variable selling overheads (1,500 units X 6) 9,000
Total Variable Cost 31,500
Contribution (Sales – Variable cost) 28,500
Less: Fixed Cost (Fa + Sell) 25,000
Profit 3,500

Problem – 5
XYZ Ltd. has a production capacity of 2,00,000 units per year. Normal
capacity utilization is reckoned as 90%. Standard variable production
cost are Rs. 11 per unit. The fixed costs are Rs. 3,60,000 per year.
Variable selling costs are Rs. 3 per unit and fixed selling cost are Rs.
2,70,000 per year. The unit selling price is Rs. 20. In the year just ended
on 30th June, 2012, the production was 1,60,000 units and sales were
1,50,000 units. The closing inventory on 30 th June was Rs. 20,000 units.
The actual variable production costs for the year were Rs. 35,000 higher
than the standard.
1. Calculate profit as Per Absorption Costing and Variable costing
2. Explain the difference in the profits.

Solution
Income Statement (Absorption Costing)
Particulars Rs
Sales (1,50,000 units @ Rs. 20) 30,00,000
Production Cost
Variable (1,60,000 units @ Rs. 11) 17,60,000
Add: Increase 35,000
Fixed Cost (1,60,000 units @ Rs. 2)* (3,60,000/1,80,000 = 2) 3,20,000
(1,60,000 + 20,000) = 1,80,000
Cost of Goods Purchased 21,15,000
Add: Opening stock (10,000 units @ 13*) – 11 +2* 1,30,000
22,45,000
Less: closing stock (21,15,000/1,60,000X 20,000) 2,64,375
Cost of Goods Sold 19,80,625
Add: Under absorbed fixed production overheads (3,60,000 – 40,000
3,20,000)
Total Cost of Goods sold 20,20,625
Add: Non production Costs
Variable selling costs (1,50,000 units @ Rs. 3) 4,50,000
Fixed Selling costs 2,70,000
Total Cost 27,40,625
Profit (Sales – Total Cost) 2,59,375

Income Statement (Variable Costing)

 Particulars Rs
Sales (1,50,000 units @ Rs. 20) 30,00,000
Production Cost
Variable (1,60,000 units @ Rs. 11) (17,60,000 + 35,000) 17,95,000
Variable selling cost (1,50,000 X 3) 4,50,000
Cost of Goods Purchased 22,45,000
Add: Opening stock (10,000 units @ 11) 1,10,000
23,55,000
Less: closing stock (17,95,000/1,60,000X 20,000) 2,24,375
Total Variable Cost 21,30,625
Contribution 8,69,375
Fixed costs (prod + Sell) (3,60,000+2,70,000) 6,30,000
Profit 2,39,375

Problem – 6
Top Class company supplies you the following standard cost per unit for one of
its product
Direct Materials Rs. 1.60
Direct Labour Rs. 1.50
Variable Factory Rs. 1.20
Fixed Factory Overheads Rs. 3.00
Production at normal capacity is 2,00,000 units. Variable selling and
administration overheads per unit Rs. 0.50 and fixed selling and administrative
overheads are Rs. 75,000 per year. Production and sales data for the year 2011
and year 2012 are as follows:
Units produced in the year 2011 2,00,000
Units sold in the year 2011 1,60,000
st
Inventory – 31 Dec – 2011 68,000
Units produced in the year 2012 1,50,000
Units sold in the year 2012 1,80,000
Selling price in each was Rs. 10.50. Prepare Income statement for two years
under
1. Absorption Costing
2. Variable Costing
Basic Data
Year 2011 2012
Production units 2,00,000 1,50,000
Sales 1,60,000 1,80,000
Opening Inventory 28,000 68,000
Closing Inventory 68,000 38,000